Constructing Macroeconometric Models: The Case of Kazakhstan

Macroeconometric models designed for forecasting and simulation of the economy have
proven to be an invaluable tool for policy makers the world over. The development
of such models is an arduous task involving the collection of large amounts of data,
estimation, calibration and simulation of the model over many sample sub-periods.

The National Bank of Kazakhstan is moving from a monetary policy which targets the
exchange rate to one which targets inflation directly and has requested assistance
in developing a macroeconometric model for policy analysis. The project was initially
funded by the U.S. Agency for International Development and now is funded by the Asian
Development Bank. David Kemme of the Fogelman College of Business & Economics is estimating
and simulating a medium sized macroeconometric model of the Kazakhstan economy and
guiding a team of researchers in the Research and Statistics Department of the National
Bank of Kazakhstan.

The model Kemme is creating is designed for forecasting and policy simulation to assist
the Monetary Policy Technical Committee in determination of medium term policy instruments.
A preliminary version of the model has already been created, and the first forecasts
by the team were presented at an intergovernmental roundtable in Astana, the capital
of Kzakhstan.

The research team consists of David Kemme (dmkemme@memphis.edu), in the Economics Department, Warren Coats and Sabit Khakimzhanov, ADB consultants,
and Indira Talkhanbayeva, Saida Agambayeva, Nurgaisha Turekhanova, Rufina Shagiakhmetova,
Vitaly Tutushkin, Bebit Konurbayeva, and Aliya Algoshina, research economists at the
NBK.

The transition from central planning to markets has been a challenge for policy makers
in Eastern Europe and the former Soviet Union. As the economies have evolved structurally,
policies have evolved as well.

With respect to the evolution of monetary policy, most transition economies initially
adopted a fixed exchange rate monetary policy regime. The fixed exchange rate served
as a nominal anchor and if the currency is undervalued stimulates exports in the short
run. As the macro economy stabilizes the fixed exchange rate cannot be maintained
and the monetary authorities then begin targeting a monetary aggregate. This has
also proven to be problematic since the economies started with very low levels of
monetization and unstable money demand. A more appropriate strategy would be to target
inflation directly, and the monetary authorities in several countries, Hungary, Poland
and the Czech Republic in particular, have done so and have successfully reduced inflation
to meet the Maastricht criteria for EU accession.

In making such policies there are many practical questions. First, in the movement
from a fixed exchange rate to a floating rate with a money target, what should be
the operational target? In other words, how much exchange rate volatility should
be allowed and what changes in the monetary base are necessary to accommodate the
resulting changes in foreign exchange reserves, and then what are the changes in domestic
inflation resulting from the change in the monetary base?

Kemme and Gennady Lyakir, a Ph.D. student are examining the first policy transition
in the Czech Republic by focusing on “exchange market pressure” which is a function
of exchange rate change and monetary base changes. Typically policy makers move from
a fixed exchange rate to a managed exchange rate to a float to avoid trade and capital
flow shocks. However, if exchange rate changes are excessively dampened by increases
in the monetary base there will be incipient inflationary pressures. If the exchange
rate floats, reducing the inflationary pressures, there are negative effects on trade
and capital flows. We estimate exchange market pressure and examine whether it is
a useful guide for policy makers in the Czech context.

The research team from the Department of Economics consists of David Kemme (dmkemme@memphis.edu) and doctoral student Gennady Lyakir.

Forecasting Macroeconomic Activity in Countries with Limited Data

Researchers in the Fogelman College of Business & Economics are examining how to forecast
macroeconomic activity with limited data. A major problem in the analysis of macroeconomic
policy in most economies, and transition economies in particular, is the small sample
size and large idiosyncratic variation.

A mixed-estimation method incorporating prior information from OECD (Organization
for Economic Co-operation and Development) country data is developed to estimate parameters
of a reduced form transition economy macroeconomic model. An exactly identified structural
vector autoregressive model is constructed and impulse response functions (for a monetary
policy shock) for three transition economies (the Czech Republic, Hungary and Poland)
are estimated.

The method provides a systematic way to analyze monetary policy in transition economies
where data availability is limited. The methodology is presented in a working paper
of the St. Louis Federal Reserve Bank Research Department “Using Extraneous Information
to Analyze Monetary Policy in Transition Economies,” http://research.stlouisfed.org/wp/2004/2004-034.pdf .

The research team includes David Kemme (dmkemme@memphis.edu), in the Economics Department, and William Gavin of the St. Louis Federal Reserve
Bank.